Reinsurers’ ties with direct writers are changing

Life reinsurers continue to regroup and rethink retention levels and pricing, according to rating agency analysts.

“Steady demand combined with reduced supply have not only increased pricing power but have also greatly improved the terms by which the game is played,” writes Rodney Clark, a credit analyst with Standard & Poor’s Corp, New York.

In the report, titled “Consolidation Breeds Strength for a Stable Life Reinsurance Sector Outlook,” two approaches to the shrinking market are outlined: “playing hardball with clients” and raising prices, or “grabbing additional share.”

The latter, according to the report, is illustrated by the acquisition in late 2004 of ING Groep N.V.’s individual life reinsurance business by Scottish Re Group, Ltd., Hamilton, Bermuda.

The “little fish eats big fish acquisition” of the business from the U.S. unit of ING, based in Amsterdam, was a springboard that pushed Scottish Re into the No. 2 spot among reinsurers with about a 15% market share as measured by insurance in force.

Illustrating the first approach, Swiss Re, ranked No. 1 with a nearly 30% share, the report continues, took a different tack and “retrenched by taking full advantage of its market heft.” In 2004 the company, based in Zurich and New York, conducted reviews of its clients “in most cases raising prices and in some cases refusing to re-bid at all.”

One reason for this strategy, according to the S&P report, is the strength of margins in its property-casualty reinsurance business, which makes it possible “to accept stunted growth in life [business] for the sake of greater profitability.”

Reinsurers also are tightening underwriting standards for direct writers that companies must adhere to or risk arbitration or refusal to pay a claim, the report says.

Clark says equilibrium is being reached in which direct writers will consider taking on more risk rather than pay for reinsurance. In fact, he says, a few direct writers already are buying less reinsurance.

Part of the reason for the tighter underwriting criteria, according to Clark, is that “life insurers had become more like asset managers and are not keeping risk. We are seeing the pendulum swing.”

In some cases, he continues, direct writers are starting to restructure their programs to retain more of the risk.

And, to some extent, new entrants such as Wilton Re, Greenwich, Conn., ACE Tempest Life Reinsurance Ltd., and Max Re Ltd., both in Hamilton, Bermuda, could provide some relief for direct writers, according to the report.

Securitizations and other capital market transactions may also become more common, according to Clark.

Although securitizations are expensive for companies that are the first to use them, prices come down over time as the market becomes more comfortable with risk and modeling of specific risks, he adds. However, these transactions will be completed by the top 20 large primary writers because scale is needed to do them, Clark says.

The Standard & Poor’s report says large reinsurers are looking for new alternatives, including the Asian market, for profitable growth outside of the “traditionally highly commoditized Western markets.”

This search may start in Japan and Korea where there are more developed markets and there is more of a willingness to cede risk, says Clark. Taiwan and Malaysia are other areas in Asia where reinsurers may look for new opportunities, he adds.

Although China also offers potential, because it is a newer market, that potential will not be realized by reinsurers for another decade or so, he adds.

Martha Butler, a senior director with Fitch Ratings’ Chicago office, says that “in the past, reinsurance rates were so cheap that it didn’t pay to keep it [business] all. Prices are getting back to what they should be. Unless you want to be a distributor, you should be taking some of that.”

But the life reinsurance market is more concentrated right now, she continues. While consolidation may continue, she says, the process is in the latter stages.

For acquirers, the risk is that business that was aggressively priced in the late 1990s could now start to impact them negatively, Butler notes.

Concentration among the top 10 players has increased by almost 15% and the top 10 competitors are increasingly stratified into large, medium and small companies, she explains. Large reinsurers control the market in a semi-oligopoly, according to Butler. The top 5 companies held 79% of life reinsurance in force and wrote 81% of reinsurance assumed in 2004, she continues.

That consolidation is making it possible for reinsurers to negotiate more favorable treaty terms and more discipline among direct writers, Butler says.

And, going forward, according to Butler, reinsurers will continue to focus on mortality risk and be more cautious of businesses such as variable annuities, equity indexed annuities and long term care, where the risks are less certain.

Even with the changes occurring in the life reinsurance market, Butler says that as a group the ratings outlook is pretty stable. This is particularly true of reinsurers who are part of a bigger, diversified insurance group or a unit in a diversified reinsurer, she adds.

Joel Levine, a senior vice president and team leader with the life insurance group of Moody’s Investors Service, New York, says that life reinsurers are “certainly firming up the terms and conditions of contracts. They are treating cedant company accounts with much less latitude. The old gentleman’s agreement is fading fast.”

Those direct writers who are outside of the box will find out that reinsurers are looking at the relationship strictly as a contractual relationship, he adds.

Levine adds that there is a hardening of pricing, in general. In part, the shift can be attributed to aggressive marketing by ceding companies and pressure on pricing, he says.

Some ceding companies may start to reassess pricing of products, while others may accept lower profitability, Levine says. However, he thinks products won’t be taken off the table but, rather, will be restructured or have features tweaked such as being less generous with guarantees. There may be more of a tightening on reinsurance of universal life with guarantees and other products that focus on older age mortality, according to Levine.

Securitizations may be an option, he continues. The expense of executing a securitization will need to be weighed against the capital efficiency of moving reserves permanently off the books, Levine adds.